Effective Financial Management

Effective Financial Management Rwanda Civil Society Strengthening Project November 2010 This training was based on InsideNGO.2009.Introduction to Financial Management.

Auditing AUDIT PLANING AND CONTOL The International Auditing Standards (ISA) requires an auditor to do the following in order to carry out an audit efficiently. To plan his work. To control his work. To record his work. (a) AUDIT PLANNING The audit plan is a detailed schedule of the activities to be conducted in an audit and specifying the resources needed. Audit planning helps the auditor: (a) Direct and control the audit work. (b) Device a means of achieving audit objective. (c) Complete the audit work in time for the Annual General Meeting. (d) Concentrate on key areas i.e. sensitive ones. (e) To use audit staff optimally and complete work on time. Planning procedures (Preliminary) Before drawing up an audit plan the auditor should do the following preliminaries. (a) Review last years audit file especially the current audit file (b) Identify changes in clients procedures and accounting system (c) Assess effect of the changes in legislation and accounting practices (d) Review interim management accounts and budgetary system (e) Establish relevance of work done by the client internal audit department (f) Establish extent to which schedules are to be prepared by the client himself (g) Establish timing of the audit work (h) Identify number of experienced staff required to carry out the audit (i) Assess briefing requirement of each audit clerk Description of desired procedures of audit planning 1. Review previous years audit file (current file) and note (a) Difficult areas encountered (b) Sample profit and loss account and balance sheet 2. Consult company s senior staff and: (a) Get an idea regarding current trading circumstances (b) Get an idea of significant changes in company personnel (c) Assess changes in location e.g. new branches (d) Assess changes in accounting procedures 3. Review management interim accounts 4. Estimate audit time requirements by considering: (a) Division between interim and Final audit (b) The clients ability to print accounting statements and audit reports Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 1

Auditing 5. Determine the degree of cooperation expected from the internal audit department e.g. stock counts, wage payments, verification of mobile assets, branch visits, cash counts, preparation of schedules. 6. Assess the availability of different levels of audit staff in terms of experience, ability and competence. 7. Brief audit staff in problematic areas e.g. areas managed by relatives. 8. Prepare an audit Memorandum-a summary of what is to be done by each member of the audit staff: This memorandum will contain: (a) Each item in the financial statement, how, when, and by whom it will be verified. (b) Staff usage with time budgets. (c) Timing requirement Advantages of audit planning 1. Planning in advance solves the problem of client companies with similar year ends and timing requirements e.g. AGMs 2. Solves the problem of trained manpower by utilizing available staff optimally. 3. Delay in submitting information or documents by the client are accommodated in the plan. 4. Planning optimizes the effort in a two-part audit (Interim and Final) especially when the final audit is time critical. 5. Use of audit test requires careful planning to obtain good results in time. 6. Planning is essential for large companies where time is critical. 7. Planning assists to concentrate audit efforts on problem areas avoiding wastage of time. 8. Planning facilitates control. Problems in audit planning 1. Client s transactions are not evenly distributed throughout the financial period and may peak and drop haphazardly make it difficult to plan for. 2. Sudden changes in the business may make the plan absolute and necessitating changes. 3. Some client may make the plan unworkable by delaying information and documents leading to delays in Audit work. 4. Staff turnover of auditing staff e.g. illness, desertion that may disrupt the audit plan. 5. A good plan may be rendered useless by lack of qualified audit personnel. 6. Abrupt assignments to audit firms in form of receivership, liquidations and investigations that may disrupt the audit plan. Ways of minimizing audit planning problems 1. Keeping close liaison with clients to avoid delays in submitting documents or information. 2. Concentrate more effort on interim audits and less on final audits. 3. To use long-range strategic plans anticipating the auditing needs of various clients. 4. Staffing requirements should be planned in advance and a small stand by staff kept for eventualities such as desertion. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 2

Auditing 5. Set up special department to take up sudden receivership, liquidation assignments. 6. Ability to engage part time audit staff often the need arises. (b) Audit control To achieve acceptable auditing standards audit control is important. Audit control can be achieved if: a) Work is allocated to trained, proficient and experienced staff. b) Staffs understand their responsibilities through proper briefing. c) If proper recording is done of audit work d) There is adequate review of audit work by a senior auditor. Procedures to Ensure Proper Audit Control a) Proper allocation of duties meeting experiences and competence. b) Proper briefing on what to do, how and when. c) Audit staff briefed to report problem areas to the audit manager. d) Properly completed working papers that are comprehensive. e) Management review of work done by junior audit staff and completed working papers and acknowledgement by the audit manager. f) Use of audit completion lists e.g. on debtors, assets. Etc g) Audit manager should consult partners for special opinions on issue that are not clear to time. h) Constant reviews of audit work performed. (C) AUDIT RECORDING The auditor is supposed to record all-important items he comes across during the course of his audit work. This is important because when it comes to the final review he cannot check the accounts again. Recording is done in working papers. Working papers: Working papers are all records including information recorded, gathered form third parties, important documents collected during the course of an audit. Working papers provide evidence of work done. Features of good working papers 1. Should be properly headed. 2. Should indicate period covered or when collected and recorded 3. Properly indexed for crosschecking. 4. Comprehensive enough. 5. Symbols used should be explained. 6. Kept safely to avoid misuse or destruction. 7. Preserved in the current file for at least 5 years and in the permanent file for at least 15years. 8. Periodically updated especially in the permanents file. 9. Where the auditor uses personal judgement this must be explained. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 3

Auditing 10. Should be neatly arranged and kept in a suitable file or medium. Advantages of collecting working papers 1. Used as a basis of planning the current audit. 2. Means of controlling the current years audit by reviewing them. 3. Enable the auditor to form an opinion on the true and fair view and whether the company has complied with statutory requirements. 4. Those collected in one part of an audit can be used in another part. 5. Audit working papers are used to assist in investigations on the company s financial affairs. 6. Can be used as evidences of work done if the auditor is sued for negligence. 7. Are collected as evidence of work done by each audit clerk who can be questioned in case of omissions. Gathering of audit working papers 1. Taking copies of client s statements e.g. P & L account, Balance sheet, Trial balance etc. 2. Taking notes of areas of weak internal controls, material errors and frauds, areas of lack of cooperation, or explanation. 3. Filing up evidence from third parties e.g. Debtor and creditor circularisation, balances certificates, contingent liabilities, bills discounted, values certificates etc. 4. Auditors own judgement put on record and filed. 5. Important Company documents e.g. Memorandum and articles of association. Storage of audit records Working papers are kept in two files: 1. The current audit file. 2. The permanent audit file. Current audit file Contains information about the accounts being audited i.e. Information about the current year. The file is closed at the end of the current audit. Contents of the current audit file 1. Copies of accounts and statement under audit fully authenticated by director s signatures. 2. An index covering all working papers in the file. 3. Internal control questionnaires and answers and flow charts. 4. Audit programmes and tests and dates carried out. 5. Schedules of each item in the balance sheet and details eg. Value, ownership and existence and supporting documents 6. A schedule of each item in the profit and loss account. 7. A checklist concerning compliance with statutory disclosure, provisions for depreciation, bad debts, taxation etc. 8. A record of questions asked and answers given. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 4

Auditing 9. A schedule of important working ratios e.g. Gross profit, current ratio, stock turnover ratio etc. 10. A record of minutes of meetings of shareholders directors etc. 11. Copy of management letter highlighting weaknesses in the internal control system and how rectifications have been done. 12. Letters of representation given by directors and written on the client s letter head the client s confirmation of auditor s opinions on matters such as stocks, contingent liabilities. Permanent file Contains information of continuing importance to the auditor i.e. can be used beyond a given financial period. 1. It contains only information of permanent importance 2. It should be updated after each audit. 3. It should be indexed. Contents of the permanent 1. Index to the file 2. Statutory material governing the conduct of the accounts and audit e.g. accounting guidelines, audit guidelines. 3. Memorandum and articles of association, partnership deeds, constitutions (clubs and societies). 4. Address of company s registered office and other premises 5. Copies of documents of continuing interest to the auditor e.g. Letters of engagements, minutes of the meeting that appointed the auditor, royalty agreements, debenture deeds, certificates, lease agreements, guarantees by or for the company etc. 6. Organizational chart. 7. List of books and records and names, positions, specimen signature and initials of responsible people keeping these books. 8. Outline history of the company e.g. Reserves, provisions, share capital, acquisitions. 9. Accounting matters of importance e.g. Company accounting policies e.g. Depreciation policy, stocks stock valuation policy. 10. Note of interviews and correspondence and reference to previous letters of weakness. 11. Note of company s position in the group e.g. holding, subsidiary or associate. 12. Clients internal audit and accounting instructions 13. A list of directors, their shareholding and service contract. 14. A list of the company s advisors such as bankers, stockbrokers, lawyers and insurance brokers. 15. A list of the companies insurances. 16. Latter s of representation Contents which over-lap in the two files 1. Index to the file. 2. Records of minutes of shareholders and directors. 3. Letters of representation. 4. Management letters (highlighting weaknesses). Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 5

Auditing 5. Statements of accounts (balance sheet and profit and loss accounts). Limitations of gathering working papers 1. Lack of cooperation, delays in submitting schedules, statements or documents. 2. Missing or misplaced documents not available for photocopying 3. Third party delays or bias if they collude with management 4. Working papers may be insufficient if collected by inexperienced staff. 5. The auditor may not understand the technical nature of a clients business leading to insufficient information. 6. It may be difficult to compile working papers collected by different people, hence making cross-referencing difficult. 7. Weak internal control systems may make it difficult to compile working papers e.g. lack of proper records, proper schedules. 8. Staff turnover that may interfere with the collection of working papers. Advantages of working papers to the auditor 1. Facilitate the final review. 2. Review of the previous year working papers assist the auditor to concentrate on key areas. 3. Can be used in a court of law as evidence of work done if the auditor is sued for negligence. 4. Assist the auditor to detect errors and frauds in cases where figures are changed. 5. Are used on the basis of planning the current year s auditor. 6. Working papers can be used to assist investigations that assist the auditor and the company. 7. Highlight the approach to an audit through the review of the informal control systems, flow charts, programmer and tests. 8. Highlight changes in accounting systems, accounting principles and policies. 9. Used as training materials to new audit staff. 10. Used as evidence of work done by each audit clerk and as such can be used for audit control. 11. Minimize the risk of duplicating the auditor s effort. 12. Used as the basis of charging fees. 13. In case of disruption of the audit due to illness, the working papers will indicate how much as been accomplished and allows new staff to determine where to continue with the audit-ensuring smooth flow of the audit. 14. In cases of catastrophic losses e.g. Fire in the clients business the auditors working papers can be used in determining insurance claims. The auditor s lien (ownership of audit working papers) As a contracted person, all working papers belong to the auditor and have lien over them until his fees are paid except for: 1. Returns from branches 2. Bank letters 3. Income tax returns 4. Letters of circularisation Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 6

Objectives: Participants will be able to: Explain complex and varying purposes of financial management Explain international accounting structures, standards, policies and procedures to serve the financial management needs of non-governmental organizations Utilize this knowledge to review and analyze their current accounting structures, standards, policies and procedures for their comprehensiveness and effectiveness

Overview of training: Introduction (40 minutes) Accounting standards (20 minutes) Break (15 minutes) Continue with Accounting standards (1.5 hours) Practical inform on accounting (1 hour) Break (lunch?) 30 minutes Budgeting (2 hours) Financial reports (1 hour) Break (15 minutes) Financial management policies (1 hour) Practical work (2 hours)

Introduction Why is financial management important?

Introduction What does financial management involve?

Introduction What does financial management involve? Planning, Organizing, Controlling and Monitoring are the building blocks of the management of the financial resources of an organization These activities need to be done on an ongoing basis to keep the NGO sustainable

Introduction: Role of managers Financial managers should continually: Plan budgets, Implement the program and track expenses and achievements and Review if spending and results are meeting the original plan

Introduction: Financial control Financial control refers to the systems and procedures that make the financial resources of an NGO properly handled. Financial control is crucial.

Introduction: Responsibility Who is responsible for financial management? Legal liability Founding document: with named members of governing body and its powers and responsibilities CEO enforces the board s policy, so they must have system to monitor the results and the NGO s practices and finances

Introduction: Wrap-up How do the theories of financial management compare to your current operations?

Accounting standards Basics of financial management Accounting tools Design of system structure Finance manual & policies

Accounting standards Basics of Financial Management: Accounting = Record how funds have been spent (to Organize and then Monitor) Financial Planning Monitoring Internal Controls *Back to the building blocks of financial management, mentioned in the introduction.

Accounting standards Financial accounting: is the realm of work of tracking monetary transactions through recording, classifying and summarizing informational for various purposes. Financial accounting should be: accurate, timely and efficient in order to minimize staff effort

Accounting standards Management accounting: is the realm of work of analyzing the financial information generated by the financial accounting in order to make comparisons and informed strategic decisions about the organization.

Accounting standards (Mango February 2006; InsideNGO 11/2009 page 76).

Accounting standards

Accounting standards: Accounting tools What tools are your NGOs using now to manage finances and planning?

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Accounting standards: Accounting system design System design is an organizational aspect of financial management. The accounting system organizes how expenses are grouped or categorized and tallied based on the needs of the NGO.

Accounting standards: Accounting system design Accounting systems should be based on the NGO s: Size and structure Resources Reporting requirements Projects and activities Volume and type of financial transactions

Accounting standards: Designing an accounting system Cost structures: Restricted funding Pots of funding as various levels Direct and indirect costs Streamlining categories to feed into overall financial picture of the organization.

Accounting standards: Designing an accounting system Chart of accounts Account name, Reference number Description of the type of expenses that should be labeled under the category

Accounting standards: Designing an accounting system Q&A Design or modify an accounting system for your NGO

Accounting standards: Financial Manual and Policies Finance manual and policies Suggested components to include A few simple policies Standardized financial cycles (basic components to consider having) Suggested standard forms to create

Accounting standards: Financial manual and policies A finance manual might include sections on: Financial accounting routines The Chart of accounts and cost center codes Management accounting routines The budget planning and management process Delegated authority rules (i.e. who can do what) Ordering and purchasing procedures Bank and cash handling procedures Management and control of fixed assets Staff benefits and allowances Annual audit arrangements How to deal with fraud and other irregularities Code of conduct

Accounting standards: Financial manual and policies An NGO should have or create: Standard forms Organizational chart Job descriptions and clear levels of financial authority Standard financial calendar:

Accounting standards: Financial manual and policies Standard forms often include: A component requiring signatures of specific job titles that must approve an expense before it is authorized. Specifications of relevant documentation to support the need and authenticity of the expense

Practical information on accounting Brief overview of types of accounting Meeting the minimum standards Documents to keep Books to keep Balancing the books

Practical information on accounting: Types of accounting Cash accounting: is a simple and effective form of accounting Payment are recorded in a bank/cash book as they are made Incoming transactions are likewise recorded in the bank/cash book when received

Practical information on accounting Accrual accounting: this is a more complex accounting system that records the dual aspect of each transaction, that is the receiving and giving of each transaction. Instead of recording transactions in a bank or cash book, these are recorded in a general ledger. Records are made as expenses occur and income is recorded as it is earned

Practical information on accounting: Meeting the minimum standards Third party documents should be kept to support every transaction taking place When labeling and filing, separate documentation under Paid and Received Keep financial documentation consistent both to help your organization stay organized and to avoid having incomplete or inconsistent files, which may look suspicious to auditors

Practical information on accounting: Balancing books Books should be balanced and verified monthly Cash accounting: compare records with bank statements and cash box Accrual accounting: (expenses + bills) must equal (income + credit (money owed to the organization))

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Budgeting Introduction Why budgeting is important Who needs budgets for what? Types of budgets How to budget

Budgeting Why is budgeting important?

Budgeting: Who needs budgets for what purposes Funders: to understand NGOs financial requirements and to track accuracy of spending Accountants: to manage expenses Program managers: to track and monitor spending and the rate of spending (or burn rate) Managers: to plan strategically Fundraisers: to show public goals and where funds will be spent

Budgeting: Type of budgets Planning budgets Cash flow forecasts Capital budgets

Budgeting: How to Line-item based vertically and time based horizontally Budget notes Budget must come from the narrative and activities, rather than the other way around. Get accurate figures from people that know real costs Be careful not to underestimate costs you have to do the work! Inform the donor if costs change during implementation

Budgeting: Working on a budget

Financial reports Annual financial reports what to include, purposes served (internal and external) Ongoing (monthly and quarterly) financial reporting Purpose of reporting Skills of a budget analyst Relationship with the donor

Financial reports: Annual reports Usually produce about 6 weeks after the end of the fiscal year Should show: where money has come in from, for what purposes, how money has been allocated what has been achieved by the organization Internal and external uses

Financial reports: Ongoing reporting Financial reporting should also be done quarterly and monthly Cash flow reports to ensure that sufficient funds are available for upcoming activities and operational costs Budget monitoring reports to compare actual spending to budget allocations and to analyze variances in spending

Financial reports: Budget analysis Recognize issues Identify what information is relevant to whom Present that information clearly and succinctly to managers Find allowable and feasible solutions to issues to present to managers Address issues effecting over spending or under spending

Financial reports: Donor relationship Donors will expect circumstances to change Be transparent and keep donors informed Changes may be able to be made: Under spending increase activities or request a no-cost extension Over spending close early, reduce costs or apply for a cost extension Still within overall budget with changes - realignment

Financial reports Assessment of NGOs financial reporting

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Financial management policies Manage fraud and internal risk The basics: Delegate authority, Separate duties, Reconciliation, Cash control, Physical control, Accountability reporting Audits

Financial policies: Delegated authority Governing board and Chief Executive Officer Delegated authority document including: Placing and authorizing orders for goods and services Signing checks Authorizing staff expenses Handling incoming cash and checks Access to the safe and petty cash Checking and authorizing accounting records Signing legal undertakings

Financial policies: Delegating authority Financial authority must be defined and documented from most junior-levels up No one can authorize transactions for which they will personally benefit Subordinates must not authorize payments to managers

Financial policies: Separate duties Different people should be responsible for ordering goods, receiving goods, authorizing the payment, keeping the accounting records and reconciling the accounts. Establish procurement processes Upper management review Employees encouraged to report irregularities Irregularities should be swiftly and professionally investigated

Financial management policies: Reconciliation Reconciliation: the bank or cash book should be reconciled monthly and the petty cash weekly Rules for cash control should be established

Financial management policies: Physical controls Safes Safeguard fixed assets

Financial management policies Review and assessment

Internal audits Why What is reviewed The option of hiring an external audit

Internal audits Internal audits often include checks on the: Financial accounting systems and procedures, Management accounting systems and procedures Internal control mechanisms

Internal audits Self-assessment and plan of action

Seven Principals of Financial Management Consistency The financial policies and systems of an NGO must be consistent over time. This promotes efficient operations and transparency, especially in financial reporting. Systems may of course be modified and improved, which may cause changes. Inconsistent approaches to financial management may indicate that financial information is being manipulated. Accountability NGOs must explain how all resources (including equipment) are used and the result of their use. NGOs have an operational, moral and legal duty to explain their decisions and actions, and submit their financial reports for scrutiny. Transparency NGOs must follow the stipulations in their funding agreements regarding information to be provided to funders and stakeholders. Financial and programmatic reports should be thorough, accurate and timely. Viability To be financially viable, an organization's expenditure must be kept in balance with incoming funds. The governing body and managers should have a strategy regarding this and be able to show how the NGO will meet its financial obligations and carryout programmatic commitments. Integrity Individuals in the NGO must operate with honesty and integrity. Managers and Board members must lead by example, following policy and procedures and declaring any conflicts of interest. The integrity of financial records and reports is dependent on accuracy and completeness of financial records. Stewardship An organization must manage its financial resources to make sure that they are used for the purpose intended - this is known as financial stewardship. The governing board is ultimately responsible for financial stewardship and work with managers below them to plan, monitor and control finances. Accounting standards, The system for keeping financial records and documentation must observe internationally accepted accounting standards and principles and be understandable to any accountant in the world. Resource: Mango 2006; InsideNGO 2009. Introduction to Financial Management, page 14

Financial Management Tools Planning: Strategic plans, business plan, activity plan, budgets, work plans, cash flow forecast Organizing: By laws, organizational charts, job responsibilities, chart of accounts financial manual and budgets Controlling: Budgets, delegated responsibility, defined levels of authority, systems to reconcile spending, procurement procedures, internal and external audits Monitoring: Evaluation reports, budget monitoring mechanisms, cash flow reports, reconciling finances, bank statements, Resource: Mango 2006; InsideNGO 2009. Introduction to Financial Management

Analysis of Accounting Systems Size and structure: How many employees work exclusively or primarily on finances? 1. How many employees work partially on finances? 2. Does the current structure and system allow everyone access to information that needs it? 3. Does the current structure allow program managers to input information? 4. Is the current system overly bureaucratic? 5. Is the current system sufficiently organized /structured? 6. Do you feel that changes should be made to the accounting system to better fit the size or structure of the NGO? Resources: 1. List resources: 2. List resource constraints: Reporting requirements: 1. Does the current accounting system meet the reporting requirements? If not, why? 2. Are there multiple programs with multiple reporting cycles? If so, is this a problem for the current system? 3. Is varying information required by different programs? If so, how is this dealt with? 4. Can all programs use the same reporting preparation? 5. To what level of detail do current funders require financial reporting?

6. Are the accounting systems able to easily track that information? 7. Does the accounting system currently allow all programs financial information to be compiled to create an overall picture of the NGOs financial situation? Projects and activities: 1. How many programs exist at the organization? 2. Do the programs have common categories of expenses? 3. What are some of the categories of spending? Volume and type of financial transactions: 1. Does your NGO have accounts directly with vendors? 2. Are most payments made in cash? 3. Does your organization give grants or microloans to other parties? If so, are financial systems set up to manage this process well? 4. Does the current system track expenses by: cash and credit? General: 1. Do all managers help code finances? If so, how and when is this be done? 2. What do you feel are your NGO s weaknesses with the current financial system? 3. What steps need to be taken to improve your NGOs financial accounting and management accounting? 4. What levels/categories/classification of funding or information about the transaction would be helpful to be tracked that is not currently being tracked or recorded? 5. If anything was listed how would you propose to capture the information?

Checklist of Standard Forms and Common Policies and Procedures Does the NGO have the following standard forms: Bank reconciliation Cash Request Contract Expense report Invoice Payment voucher Purchase order Travel expense report Vehicle log Other Does policy exist for the following items: Financial accounting routines The Chart of Accounts and cost center codes Management accounting routines The budget planning and management process Delegated authority rules (i.e. who can do what) Ordering and purchasing procedures Bank and cash handling procedures Management and control of fixed assets Staff benefits and allowances Annual audit arrangements How to deal with fraud and other irregularities Code of Conduct Do any of the above mention, whose signature or what backup documentation is required? Does the NGO have an: Organizational chart Standard financial calendars for: Recording, Reconciling, Reporting expenses to date, Forecasting budgets (once or twice annually) and Preparing for audits Resource: Mango 2006; InsideNGO 2009. Introduction to Financial Management

Documents to Keep Receipt or voucher for money received Receipt or voucher for money paid out Invoices - certified and stamped as paid Paying-in vouchers for money paid into the bank Bank statements Price quotes Contracts The minimum requirements for accounting books are: Bank (or cash) book for each bank account Petty cash book General/sub ledger Journal book Payroll ledger Assets register Inventory control book

Assessment of Accounting Practices 1. What aspects of your accounting systems are done well and correctly? Feel free to write a short assessment as well as consult the checklist below. All transactions captured All transactions are recorded in a consistent systematic manner Accounts and transactions are reconciled monthly At this time, the duality of each transaction is captured 100% of the time Accounting documents are filed in an organized manner Accounting documents are filed separated by paid and received Books are kept for all the items they should be? 2. Is bookkeeping consistent? 3. How could your bookkeeping be improved? 4. Are the systems currently used efficient and effective? If so, why? If not, why?

Assessment of NGO s Budgeting Techniques What (if any) changes could be made to templates, to increase effectiveness of budgeting? What (if any) changes could be made to templates, to increase efficiency of budgeting? Are there aspects of the NGO s business that are not being budgeted, which should be? Other thoughts?

Financial Reports by Stakeholder Stakeholder Project staff Managers Finance staff Board of Trustees Donors Government departments Project beneficiaries The general public Need for Financial Reports To know how much money and resources are available for their projects and what has been spent so far. To keep an eye on how project funds are being used, especially compared to the original plans. To help plan for the future. To make sure that there is enough money in the bank to buy the things the NGO needs to run its programs. To keep an eye on how resources are being used to achieve the NGO's objectives. To make sure that their grants are being used as agreed and that the projects objectives are being fulfilled. To consider whether to support an organization in the future. To make sure that the NGO pays any taxes due and that it does not abuse its status as a 'not for profit organization. To know what it costs to provide the services they are benefiting from and to decide if this is good value for their community. To know what the NGO raises and spends during the year and how the money is used. (Mango February 2006; InsideNGO 2009, Introduction to Financial Management, page 72)

Assessment of Financial Reporting 1. Does the NGO currently do an annual financial report? 2. Does it include: Where money has come in from, For what purposes, How money has been allocated What has been achieved by the organization 3. Does the financial report serve its internal and external needs? Please explain. 4. Does someone or a governing body analyze the financial trends and the health of the organization? 5. Are monthly or quarterly (please circle) financial reports done for: Cash flow Budget monitoring 6. Do the financial managers and budget analyst have the ability and access to resources to do their jobs? 7. Do financial managers and budget analyst have the opportunity to present issues and potential solutions to managers? 8. Are financial reports given to donors honest and transparent? 9. Are donors kept informed about spending or cost challenges?

10. Does the NGO deal with over or understanding or budget changes correctly? 11. What are your conclusions? What (if any) changes need to be made to financial reporting (internal or external reports).

Assessment of Financial Management Policies Delegation of Authority: NGO has: Governing board and Chief Executive Officer with clear levels of responsibility and authority A Delegated Authority Document exists that states who should do what in financial procedures (this document is approved by the governing board). This document includes instructions regarding: Placing and authorizing orders for goods and services Signing checks Authorizing staff expenses Handling incoming cash and checks Access to the safe and petty cash Checking and authorizing accounting records Signing legal undertakings Formal rules of authority: Financial authority is defined and documented from most junior-levels up There is a rule that states that no employee can authorize transactions for which they will personally benefit There is a rule that states that subordinates cannot authorize payments to managers Comments: Separating Duties: Different people are responsible for ordering goods, receiving goods, authorizing the payment, keeping the accounting records and reconciling the accounts. Procurement Processes are in place to: Require multiply managers review and approval of purchases, Set requirements for how purchases or made (i.e. large expenses should not be paid for through petty cash) Determine after what amount competitive price quotes must be sought out Policies and procedures regarding separating of duties: The NGOs has established that: Checks must be signed by multiple people to avoid fraud Upper management must review systems and double check accounting to ensure accounting is accurate. Employees are encouraged to be report irregularities, abuse or fraud Any irregularities must be investigated swiftly and professionally with a third person present

Comments: Reconciliation: Policies and procedures: The NGOs has established that: The bank or cash books are reconciled monthly The petty cash is reconciled weekly Cash is accounted for (recorded) as it received (and before it is used) Receipts are always given for money received Receipts are always obtained for money paid out Te surplus cash is to be kept in the bank or in a safe There are procedures for receiving cash (such as two people have to be present when a large sum of cash in withdrawn from the bank) Access to petty cash is restricted to a few people Cash transactions are kept to a minimum Comments: Physical Controls: The NGO has a safe Policies and procedures to safeguard fixed assets: The NGOs has: A list of valuable supplies and equipment and tracking number on the items The list shows the original worth of the item and the date & places it was acquired. Expensive items are insured The building and vehicles (etc.) are insured from theft, fire, flooding, etc. Comments:

Internal Audit & Plan of Action Utilizing all that you have learned in this training, review and analyze your NGOs current accounting structures. Look over your notes and the handouts provided to assess the largest strengths and weaknesses of current systems and procedures. You should consult the: Financial Management Tools, Principals of Financial Management, Checklist of Documents to Keep, Analysis of Accounting System (Structure), Standard Forms, Policies and Procedures, Assessment of Accounting Practices, Assessment of Budgeting, Assessment of Financial Reporting and finally the Assessment of Financial Management Policies. Depending on the needs you see fit, prepare the following for your NGO: 1) Summary of strengths of current system and why these elements are necessary (brief) 2) Summary of weaknesses of current system and what risks, costs or other potential consequences are associated with not changing practices or systems. 3) For each weakness, present a solution for dealing with the issue. 4) Prioritize the urgency of changes to be addresses and write a justification for why you think certain weaknesses or solutions should be addresses first. This may include a logical order of steps that would need to be taken or policies that could easily be initiated and yield greater impacts, etc. 5) From the list of priorities, start drafting a Plan of Action that includes: a) when changes will be made, b) who needs to be involved in approving changes, c) how staff will be notified or trained. 6) If this assignment is not completed during the training, it should be sent back to IREX s office when it is completed. 7) IREX management will follow-up on the progress of improvements to your NGO s financial management and impacts the changes are having on the NGO s operations and/or programming.

Auditing INTERNAL CONTROL SYSTEM Internal Control, Internal Check and Internal Audit Definition Internal control system is a system of controls, financial or otherwise (non-financial) instituted by the organisation to ensure that the business of the company is run in an orderly manner, and establishes safeguards on assets and promotes efficient and economical use of the company s resources. The types of controls instituted in a business can generally be divided into: 1. Financial controls: comprising controls over. a) Cash receipts b) Cash payments c) Financing operations rising of finance. d) Management of receivables and payables.(debtors and creditors) 2. Non Financial / Administrative controls. a) Controls over the company s personnel. b) Controls over the use of the company s non-cash assets e.g. Fixed assets c) Controls over company s policies. d) Controls over the company s procedures. Objectives of the internal control system 1. To ensure that the company runs in an orderly manner. 3. To safeguard the company s assets. 4. To ensure reliable records which are a source of information necessary for management decision making. 5. To ensure compliance with the laid down company policies. 6. To ensure that the company s personnel are effectively utilised 7. To ensure compliance with the law e.g. Companies Areas that fall under the scope of internal control system These are: 1. Internal control 2. Internal check 3. Internal auditing INTERNAL CONTROL SYSTEM Internal Control Internal Check Internal Auditing Whole system of controls: 1. Financial 2. Regulatory within the business Prepared by Emmanuel Gumisiriza FAM IREX Rwanda Arrangements for: 1. Allocation of authority 2. Division & segregation of duties. 3. Supervisory control Internal Authorisation 1. Scrutiny and check to verify transaction in accounts. 2. Elimination of fraud and errors. 1

Auditing Features/ Characteristics of a Sound Internal Control 1. Plan of organisation; organisation chart This is control over the company s personnel. This defines: a) Duties and responsibilities. b) Relationship between personnel. It s Importance a) Avoids duplication of effort. b) Avoid conflicting duties. c) Facilitates delegation of duties. d) Harmonises operations. 2. Segregation of duties Segregation of duties strengthens the internal control systems in that: a) Reduces risk of fraud, error and manipulation. b) Increase efficiency due to specialisation. c) Facilitates supervision Duties that must be segregated a) Authorisation b) Recording c) Execution d) Custody of assets e) System development for computer operations 3. Physical controls This is concerned with the custody and safety of the company s assets. Access should be limited to a few individuals at any given time. Examples of physical controls are: a) Employment of watchmen/security guards. b) Alarm systems. c) Strong electrified gates. d) Strong rooms and safes. e) Strong fences. f) Security lights. g) Strong locks. h) Mechanical checks e.g. cash registers i) Use of dogs. j) Closed circuit TV s 4. Authorisation and approved Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 2

Auditing All transaction should be approved and authorised by a responsible person. The aim is to prevent fraud and streamline the flow of authority and avoid bureaucracy and conflicting authorities. 5. Arithmetic and accounting controls This aims at assuring the accuracy of transactions. It also ensures proper recording of business transactions according to generally accepted accounting policies / principles. 6. Personnel The company should employ qualified, experienced, competent and capable people. Supervisors must be vigilant in their duties to ensure proper implementation of company policies. 7. Supervision (lower level) Supervisors must vigilant in their duties to ensure proper implementation of company policies. Supervision must be humane to boast subordinates morale. 8. Management supervision and review: Management must check interim statements, budgetary controls, standard costing statements etc. Management must supervise the whole company. 9. Defined powers These are powers at lower levels of the organisation e.g. record handling, handling of company assets etc. It must be clearly known and indicated who has these powers. For examples, the cashier should never have access to the company s ledgers. 10. Responsibilities Responsibilities should be clearly defined to boast efficiency and hold people accountable for what they do. 11. Routine and automatic checks; This take the form of surprise checks e.g. for petty cash, stock counts, cash at hand etc. 12. Control of documents; Involves control of sensitive documents e.g. Receipts, cheques, L.P.Os etc. They must be handled by responsible officers and should be pre-numbered. Must be kept securely. 13. Vacation and rotation of duties; The company should give leave to especially accountants. This is armed at: a) Checking the efficiency in their absence. b) Minimising errors and frauds. c) Boosting efficiency (having a rest) 14. Cost benefit analysis The system adopted must justify a cost benefit analysis. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 3

Auditing Advantages of an Internal Control System in a Business 1. Minimise dances of errors and frauds e.g. through segregation of duties, surprise checks, close supervisors etc. 2. Safeguards the company s assets through: a) Limiting access by use of physical controls. b) Use of proper authorisation. c) Routine checks. d) Segregation of custody and recording of assets. e) Arithmetic and accounting controls 3. Boosts efficiency and smooth flow of operations by: a) Supervisions of duties. b) Competent and reliable personnel. c) Defined powers. d) Managerial review and supervision. 4. Enables the company to achieve its goals through: a) Budgetary controls. b) Constant supervision. c) Managerial reviews. 5. Management has relevant data for decision making through: a) Qualified and competent staff. b) Routine and surprise checks. c) Use of machines. d) Constant supervision. 6. Boasts control of work and avoids duplication of effort through: a) Delegation of duties b) Defined powers c) Organisation charts 7. Facilitators efficient statutory audit s as it acts as the basis on which the auditor will perform his work-reduces tests, amount of time and audit fees. 8. Motivates employees through routine checks, constant supervision etc. 9. Identifies inefficiently and out dated policies e.g. Through: a) Managerial review. b) Internal auditing functions. c) Segregation of duties. 10. Encourages specialisation through segregation of duties. 11. A strong internal control system allows the company to grow due to less frauds, errors and inefficiency. Disadvantages of a strong internal control system 1. May cause apathy among the staff leading to lower morale due to bad supervision, poor delegation, and all leading to frustration. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 4

Auditing 2. It is expansion to install and maintain e.g. an internal auditing function, informal check, physical controls etc. 3. May be very ambitions in approach e.g. setting unrealistic controls e.g. High budgets that cannot be achieved. 4. It may be rigidly designed and inflexible to changes in the environment. 5. Rigid segregation of duties may limit staff development. 6. A strong internal control system may lead to the auditor s over-dependence on the system and thus relax his tests and leave errors and frauds undetected. Remedy to the above disadvantages 1. Supervisory staff should be trained in human relations to: a) Minimize supervision frustrations. b) Make internal check a job description to employees during their engagement. c) To employees access to management e.g. through meeting with staff. d) Everyone should participate in budgeting in order to make realistic estimates. 2. The company can consult an auditor when designing an internal control system. 3. The company should use internal auditors who should bring lax management to the attention of the directors. b. Use management auditors 4. Specialized personnel should be subject to other controls other than segregation of duties, which may increase their efficiency. How the internal control system affects the auditor work (internal auditor) 1. If effective reduces the amounts of tests in an audit. 2. Reduces number of entries to be tested in each sample. 3. Minimizes chances of errors and frauds and minimizes the auditor s liabilities to third parties. 4. Weak control necessitates a qualified report by the auditor and this will lead to negative consequences to the company. 5. An effective internal control system reduces the amount of audit evidence to gather in order to form an opinion. 6. A strong system reduces time needed for an audit and enables the auditor perform an efficient audit. 7. A strong system allows for efficient planning and drawing of programmes by concentrating on only weak areas. 8. Affects the timing of audit tests e.g. If it is weak certain tests will be undertaken early e.g. Debtors and creditors circularization. 9. Its strength or weakness will influence the number of audit staff required. 10. It will affect the audit fees charged. 11. It will affect quantity and quality of advice and forms a basis of the management letter. Techniques used by auditors to assess strengths or weaknesses in the internal control system. 1. Internal control questionnaires (ICQs) Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 5

Auditing A set of questions posed to the client by the auditor. A yes indicates strengths and a NO weakness 2. Flow charts These are diagrammatic representations of accounting functions and procedures. A Gap in flow lines indicates weaknesses. 3. Third party confirmation e.g. Debtors, creditors, bankers. Discrepancies may indicate a weak internal control 4. Compliance Tests Tests on records and transactions of the business. Check the adequacy of the company s recording. 5. Walk through test Designed to assess in general the effectiveness of the internal control system. 6. Substantive tests: These are tests on balances to see whether they are genuine. Done on balance sheet and income statement items. 7. Observation. Done in such areas as stock taking, cash account, wage payment etc. 8. Companions Using budget estimates that are compared with actual performance. Use of ratios, averages, comparing current statements with previous statement and schedules. Any deviation may indicate fraud 9. Verification of assets and liabilities 10. Vouching of entries Vouching is the examination of vouchers to see whether they are: a) For the business b) Properly authorized c) For the period under audit d) Properly recorded 11. Use of surprise checks e.g. On petty cash, cash at hand etc Action to be taken in case of weak internal control system a) Alert management immediately. b) Compile a list of weakness in a management letter and suggest solutions c) Change approach of the audit (i.e. from system) based to vouching based (audit in depth). d) Increase sample size to be investigated or tested e) Uses sufficient audit evidence-various sources of evidence. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 6

Auditing f) Change the timing of the audit-do it earlier so as to have enough time. g) If weaknesses persists inform shareholders in the audit report h) Record weaknesses in working papers and concentrate on these in subsequent audits. i) If the system is extremely weak, the auditor can produce an adverse report. How the internal control system prevents frauds. a) Plan and organisation: Prevents conflicts in duties and duplication of efforts. Provides a clear line of responsibility and prevents frauds through internal checks. b) Segregation of duties The work of one person is checked by another person. Boosts accountability. Boosts specialisation and thus efficiency and reduces chances of fraud. Segregating duties enables management to assess the performance of each employee. The internal auditor should be alert to any frauds or possibilities of fraud. 3. Physical controls Devices such as locks gates prevent unauthorised access to the company s assets Mechanised checks e.g. on franking machines, cash registrar, computers etc. Observation over company s assets. 4. Authorisation and control Vested on senior and responsible personnel Segregation of authority. Approval given to different officers, one supplementing the authority of another person e.g. in signing of cheques. 5. Arithmetic and accounting controls Minimise chances of errors and frauds. 6. Managerial Review: Subordinate staff knows that their work will be subject to review by senior personnel and this knowledge discourages fraud. 7. Supervision Both management supervision and lower level supervision will prevent fraud. Circumstances which indicate weaknesses in the internal control system: 1. Where the informal control system is in the hands of one individual that is no segregation of duties. 2. When staff are reluctant to take up their annual leave. 3. Where officials of the company have conflicting business interest. 4. Where employees are allowed to purchase goods on discount using the company. 5. Employment of relatives. 6. Where business is ran by a small group of people without an oversight committee. 7. Where the integrity and competence of staff is questionable. 8. Where here is with complex corporate structure not justified by the size of the company. 9. Failure to correct highlighted weaknesses. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 7

Auditing 10. High turnover in key accounts and finance personnel 11. Prolonged understaffing of accounts department 12. Frequent changes in auditors 13. Frequent changes in accounting policies and practices 14. Excessive payment for such services as audit and legal fees. Auditor s duties as regards the internal control system. The auditor should test it to see whether it is strong enough to prevent fraud and errors- to act as a basis of his audit. The auditor should select a few entries and check these form their original recording to the final posting. The auditor should note that a strong internal control system reduces auditor s examinations but does not reduce his liabilities and he should use his personal judgement. Internal check The internal check system is part of the internal control system to which consists for auditing purposes supervisory control over the actions and work of employees. The above supervision is achieved by: i. Division and segregation of duties such that the work of one person provides an automatic check on that of another. ii. Frequent check of one persons work by another on frequent intervals. Advantages of internal check system in business 1. Facilitates detection of errors and frauds through inter-checking. 2. Boasts efficiency of staff 3. It fixes responsibility on individuals 4. Enables the company to have accurate records because of independent checks and this improves decision-making. 5. Strengthens financial controls and thus budgetary controls. 6. Enable evaluative comparison between personnel and can lead to motivation. 7. Enables management evaluate employees. Disadvantages of internal check 1. If not well-planned may lead to bureaucracy and delays. 2. May lower morale among employees because independent and routine checks may be viewed with suspicion. 3. It may be expensive to operate in small companies 4. It may be misused if there is collusion 5. It may be over relied by management leading to relaxed supervision. 6. It may lead to high staff turnover. 7. If rigidly set it may make the company inflexible to changing needs of the business. Differences between internal check and internal control system. Internal Control System Internal Check Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 8

Auditing Broad, covers all aspects Restricted to checking of the business the company s sensitive operations. controlled by competent and qualified staff. Any person in the Organization can participate. Necessary for all business Regardless of size Ideal for big business with many operations. If weak may prompt a Qualified report If weak may not prompt a qualified report. Internal audit This is an independent appraisal of activities within an organization aimed at ensuring management efficiency. It also acts as a watch over the internal control system Areas falling under internal auditing 1. Independent appraisal of activities The internal auditor should be Independent. The importance of his independence is: i. He should enjoy everyone support in the organisation and should report to a higher authority e.g. Management or board of directors. ii. He should not develop systems, procedures or prepare records that he will be called upon to appraise. 2. His role within management Conducts a continuous audit and advises management. 3. Review of operations: Appraises financial and accounting activities and assists managers to discharge their responsibilities by giving: - Objective analysis - Appraisals - Recommendations The activities reviewed by an internal auditor are reviewed and appraised for. (a) Soundness (b) Adequacy (c) Application of accounting and financial controls. The internal auditor must ensure that information provided to management is:- (a) Timely (b) Relevant (c) Reliable (d) Accurate Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 9

Auditing (e) Complete 4. His services to management The duty of the internal auditor is to aid management. In order to discharge this duty: (a) Should be familiar with corporate policies (b) Evaluate operations from the organisations point of view (c) Should write clear and concise reports (d) Introduce corrective action immediately (e) Should review the data processing system for efficiency. Common areas between the internal auditor and the external auditor. 1. Both are internal in the strength of the company s internal control system. 2. Aim at carrying out independent evaluations 3. Both write reports either to the shareholders or management of the company. 4. Both are affected by the strengths and weaknesses of the internal control system. 5. Both have a duty to ensure that the organisation follows generally accepted principle and above all observes statutory requirements. 6. Both a concerned with detection and prevention of errors and frauds. 7. Both use the same materials and procedures in the conduct of their work. e.g. Audit programs, working papers. 8. Both may undertake continuous audits 9. Both have the responsibility of ensuring that the company is run efficiently. Factors that influence the external auditor s reliance on the internal auditor 1. Qualifications, experience of the internal auditor and his staff. 2. The level of reporting of the internal auditor e.g. If to the board of directors, there is greater independence. 3. The degree of the internal auditor s independence and this can be judged by establishing the party that appointed him. 4. The quality of his working papers e.g. His report, internal control questionnaires, tests, conclusions, programmes etc. 5. Management reliance and action on his recommendations. 6. The efficiency of the internal control system 7. Past expensive with the internal auditor. 8. The scope of the internal audit department. Ways in which the internal auditor department assists the external auditor during his work. The internal auditor can point out areas of weakness in the internal control system. The external auditor can use the internal auditor s working papers to gather evidence and plan his audit. 1. The internal auditor can explain technical operations or controls used by the client that are not familiar to the external auditor. He can cover the following on behalf of the external auditor: Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 10

Auditing i. Stock taking ii. Brach visits iii. Cash counts iv. Wage payments v. Adherence to company policies etc. 2. He can verity assets for the external auditor e.g. moveable assets. 3. Assist the external auditor in case of change in management, hence in the internal control system. 4. He can prepare schedules e.g. an asset schedules, debtors schedules on behalf of the external auditor. 5. The internal auditor can follow up recommendations made by the external auditor to strengthen the internal control system. 6. The presence of an internal auditor can reduce errors and frauds and thus reduce the external auditor s liabilities. Reasons that have led to the fast growth of the internal auditing 1. Increase in the size of businesses an inability of management to have effective control thus the need of the internal auditing department. 2. Dynamism in other business environment i.e. economic social and technical has led to frequent changes and an appraisal for such changes is required. 3. Need for knowledge to cape with increasing professional and legal requirements. 4. Competitiveness in the environment requires efficiency and thus strong internal control systems this requires an internal audit department. 5. Use of electronic data processing systems has reduced the ability of the accounting department to keep a close security of their transactions. Functions of the internal audit department 1. Acts as a consultant to other departments on matters of control 2. Reviews the activities of the entire organization to see whether they are consistent with company policy. 3. Preventive measure of frauds and errors. 4. Ensure the business operates effectively. 5. Provides feedback to management regarding success or failure of procedure. 6. Conducts investigation where: i. Frauds and errors are suspected. ii. Profit margins have charged without any apparent reason. iii. Policies are not practical. iv. Budget targets are not achieved. 7. Responsible for systems and monitoring their efficiency 8. Performs executive duties e.g. making certain company policies, board directors are executed. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 11

Auditing Advantages of the internal audit department 1. Facilitates achievement of company policies e.g. Budget target. 2. Promotes a strong internal control system. 3. Prevents frauds and errors. 4. Helps the external auditor to identity weaknesses in the internal control system. 5. Acts as a consultant to other departments. 6. Ensure company assets are safeguarded. 7. Provides information important to management decision-making. 8. Strengthens supervision 9. Reduces, through corporation with the internal auditor, time needed to prepare the final report. 10. The internal auditor is more qualified with the problems facing the company. Disadvantages of internal audit department 1. Management may over-rely on if and relax their supervisory 2. Management may deny him his independence 3. It is expensive and only ideal for large organizations 4. It may overshadow the accounting department leading to duplication of effort. 5. May create apathy in the accounting department, due to suspension. 6. If management ignores recommendations made by this department if may destroy the morale of the department. 7. May be used by top management to intimidate line managers. 8. The external auditor may over-rely on if relaxing his examination. Remedies to the disadvantages of the internal auditing function 1. The external auditor should point out over-reliance by management on the internal auditor. 2. The internal auditor should report to the board in order to safeguard his independence 3. Give the internal audit department autonomy form the accounting department 4. Design good organizational structure giving clear job descriptions for both departments. 5. The external auditor should advice the internal auditor on how to handle line managers so as not to intimidate them. Prepared by Emmanuel Gumisiriza FAM IREX Rwanda 12